The mortgage interest deduction is one of the most celebrated tax deductions in all of tax deduction-dom. It’s cited as one of the benefits of homeownership, right behind “you’re not throwing your money away,” and that fact is repeated over and over again. Unfortunately, I believe it’s misrepresented. It’s not as good as you think and I’ll explain why.

To claim the mortgage interest deduction, you have to itemize your deductions. For those who aren’t familiar with the idea of claiming itemized vs. standard deductions, you have two options when you file your return. You can either list all of your deductions, such as the mortgage interest deduction, or you can just claim the “standard,” which requires no proof.
The reason why the deduction is a myth has to do with the size of the standard deduction, which you get even if you don’t own a home. Here are the standard deductions by filing status for 2009:

Single – $5,700

Married Filing Jointly – $11,400

Married Filing Separately – $5,700

Head of household – $8,350

Qualifying widow(er) – $11,400

I recently received my Substitute IRS Form 1098, which is a form my mortgage lender files with the IRS. The form lists, among other things, all the interest I paid towards the mortgage last year – $11,521.87.

If we didn’t have mortgage interest, we would claim $11,400 as our standard deduction and we get that for free. To claim the $11,521.87, we have to pay $11,521.87 to our mortgage company! If you assume we’re in the 25% tax bracket (2010 IRS tax brackets), here’s how we make out from a cash flow perspective:

Married Filing Jointly

Single

Itemized

Standard

Itemized

Standard

Interest Paid:

$11,521.87

$0

$11,521.87

$0

Deduction:

$11,521.87

$11,400

$11,521.87

$5,700

Tax Refund:

$2880.47

$2,850

$2880.47

$1,425

Net Cash:

-$8641.40

$2,850

-$8,641.40

$1,425

Difference:

-$11,491.40

-$10,066.40

Interest paid is how much money was spent throughout the year for each case, so $11,521.87 for the homeowner and $0 for the renter (to use simpler terms). The deduction compares the mortgage interest deduction, of $11,521.87, against the standard deduction of $11,400 or $5,700, depending on filing type. The tax refund is simply 25% of that, since we are assuming the 25% tax bracket. The net cash is to the taxpayer. Take the refund they received and subtract the interest they paid. The delta is the difference between the homeowner and the renter.

As you can see, in both cases, the homeowner pays more. Much more. (and interest, unlike equity, isn’t something you get to keep)

Did you know that you can deduct real estate taxes if you claim the standard deduction? It’s Line 7 of Form L and you can deduct up to $500 (single) or $1,000 (married filing jointly) of your real estate taxes. This makes the mortgage interest deduction even less appealing since you can deduct part of your real estate taxes and claim the standard deduction.

Of course, that’s not the whole picture because there are many other factors. There are tax deductions made available to you whenever you itemize, such as charitable deductions. Also, when you rent, the idea of “throwing your money away” does have a bit of truth in it because you pay for a portion of the mortgage interest and property taxes without getting the deduction for it. Of course, at this point it is more a debate about the broader qualitative and quantitative aspects of the rent vs. buy question.

So why do people buy homes if there’s such a big difference? The difference in what homeowners pay in interest really amounts to what renters pay in housing costs. The table above omitted that because we were strictly looking at the interest deduction, not at housing costs as a whole. People buy homes because when you make those mortgage payments, part of it goes towards the home. When you rent, none of the payment goes towards owning more of that home or apartment. As the years pass and the principal portion of the mortgage payment increases, you get closer and closer to owning a home.

When you look strictly at the mortgage interest tax deduction, it just doesn’t add up financially.

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113 Responses to “Mortgage Interest Deduction Myth”

If I wasn’t self-employed and had other deductions, it would be more to our benefit to claim the standard deduction as husband & I paid “only” about $8,000.00 in mortgage interest last year.

Also, in MA renters can deduct 50% of their rent up to a certain amount (which I do not recall since it’s been quite a while since we rented) when they file state income taxes. So some of the money being “thrown away” can be deducted here.

I’m a little confused as to why this is an example of a marriage penalty.

First of all, in MA (metro Boston),$3,000/year doesn’t cover very much rent($250/mo.). So most renters, if not all, are going to be able to qualify for the full deduction as single filers.

Take, for example, two such people, paying $250/mo.+ in rent (qualifying for the full deduction), get married and move in together. If they chose to remain in one of thier current apts., they still qualify for the full deduction. Same is true if they upgrade to a bigger, more expensive apt., they’ll still qualify.

Sure, collectively, they only get half the deduction they got before, but they are, collectively also paying only half the rent they paid before (assumes they paid the same in rent before they got married).

So, how is it a penalty to get married with regards to the rental deduction? Am I missing something?

The deduction would be cut in half. Two roommates would get $6,000, one married couple in the same apartment would get $3,000. Yet the roommates could have a similar sharing agreement (share food, utilities, etc.).

Oh, okay. I was considering the simplified case where two people get married, then move into a similar living scenario that each had previously used for only one person (i.e. a married couple moving into a one-bedroom apt.).

Real life is always more complicated than the simplified example, though, so what I said IS contingent on certain assumptions. Your example is a great counter-example. Thanks for the additional clarity!

In a prior post, I recommended to alternate when you pay things like monthly mortgage payments, taxes and such to get a standard deduction one year and a higher deduction the next. i do it currently and it works. It is also perfectly legal.

I always hear this from people. It’s ok to pay mortgage interest since you can deduct it on your taxes. Getting a tax break does help the blow, but we are still paying tons of interest to the mortgage companies over the life of the loan. Since I just got married, the amount I can deduct in mortgage interest got a lot closer to the standard deduction.

Yes, but the alternative is homelessness or paying rent. Paying rent is appropriate in some cases, but generally you’re left with nothing in the end. I view mortgage interest “part of the package” of home ownership. A long-term investment.

“Why can’t people see that?” Why can’t you see that whether you are directly paying the interest or renting, YOU are ultimately paying the interest. When you rent from someone, there is a high likelyhood that they have an active mortgage on the property, and are paying interest on it. That owner isn’t going to charge you only the princial amount of their loan, they’re going to charge you principal + interest + their profit margin. Another common misconception is that as a renter you don’t pay property taxes. This is completely bogus. The home owner factors this into the payment, so that it breaks down as principal + interest + profit + (anual property taxes / 12). Still think you’re better off renting? Do you think that if you rented a place for 30 years the owner would say “OK, you don’t have to pay me anymore, and you can pass the house on to your children”? HELL NO!!! Wake up people! If you can afford to buy a house, you are MUCH better off.

if you pay 650 in rent for 15 years,and save 350 a month for 15 years vs. paying interest, taxes, repairs and upkeep and insurance that goes along with ownership and say your morgage payment is 950 a month with 4% rate you still pay a lot of interest. In the end of the 15 years if you saved the 350 and invested with interest earned you have at least 56,000 cash and you can get a house you can afford with a nice downpayment and not have to struggle to keep up a house,and repairs, upkeep etc. because in all probability, you will refinance that house and still have a morgage.

Yes, but remember you are RENTING that same place for 15 years. In the same time frame you could easily pay off an affordable home, then at the end of 15 rent it out to someone with your mindset who will then be assisting you cash flow a good chunk of dinero while you go off and buy another.

Jim, it’s interesting to read about your search for a townhome in 2005 and the decision between renting or buying. You were toying with the idea of 6% in 2005 with the breakeven around 2.5 years, or 3% with breakeven 8 years. It’s crazy to look back and see the price range you were looking at, and what you could get nowadays for the same amount, or that you could get the same townhouse for half the price probably. Hindsight is 20/20.

I agree with your math. I was disappointed when my mortgage interest deduction came out to be just under $12k, roughly the same as yours. I essentially got no extra benefits when compared to standard deductions. (I really did not get a chance to claim any other LARGE deductions.)

In the end though, I personally don’t make assumptions that mortgage interest deduction will decrease my effective interest rate. That’s a bad assumption…!!!

That’s very optimistic, but increasingly wrong. More and more services are being offered to those who pay no taxes, and they are in many cases enjoying lifestyles that are equal to tax paying citizens, but minus the stress of seeing your wealth confiscated.

There is another factor as well. I don’t know if it is common to all loans, or just to first time home buyers. However, my interest was HIGHER at the start of the loan with less paid to the principal. As time as gone on the interest/principal amounts are starting to equal out, meaning that while I pay less interest, I am also probably going to just file the standard deduction because I don’t think the interest on the home has gone over that amount.

I’ve heard of people with the capacity to pay off a mortgage but refuse to do so because they don’t want to lose the deduction. Even if you do get the full benefit (because you’re at the break-even point of standard/itemized before taking it into account) paying the interest just to get the deduction is like giving someone a dollar, having them give you 10 cents (or 15 cents, 25 cents, 28 cents, 33 cents, 35 cents) back and pretending that you won the trade.

But, hey, if you want to make that trade, I’ll be happy to give you 35 cents for your dollar.

Yes — I’m going to rethink my practice of holding onto my mortgage (10 years left @4.875%)now that I’ve read this artical. I’m getting a return of about 4% on the money now, so I thought it was more or less a wash, but now I think my logic is flawed.

I wonder though, do you feel that this type of mortgage debt could also be a hedge against inflation?

Jim, you say as a renter you are paying “a portion of the interest and property taxes.”

The reality is that, on average, as a renter you are paying *ALL* of the interest, property taxes, maintenance, improvements, and management profit on the rental.

If renters weren’t paying this, no one would be in the landlord business in the first place.

That said, I generally agree with your sentiments… the mortgage interest deduction is only worthwhile if your other itemized deductions already put you over the standard deduction amount. And, as Mark W. points out in the comment above, you have to actually PAY interest to get the deduction, so no one should be really happy about getting it.

Today, there are a number of landlords in this situation because of the housing boom and bust of the last 10 years.

As property values level-off and return to modest inflation rates, however, it would require quite an economic anomaly for this situation to remain for more than a few years. People can act irrationally for a while, but eventually their wallets catch up with reality.

One note: rents don’t need to cover an entire mortgage, only the interest portion + other expenses. Principal payments increase the owner’s equity in the property and are thus part of the profits.

I will grant you that you can find a very good deal on a rental today with the market situation, and for many folks it will be cheaper to rent than to buy… but it won’t be like that forever.

Really? So all these homeowners are going to get their 20% or even 10% of home value back in a few years? Homeowners are in the hole for years. Also, I have rented throughout the years. And just like there are good “deals” on buying a house there good deals on rentals.

Also, what equity does a homeowner who has bought in the last, say 5 years, have?

Again, you are focusing on the last 5 years, 4 of which have been in declining real estate markets. However, there are A LOT more people who purchased a home more than 5 years ago, or who are rolling equity from one house to the next who purchased their first house long before 5 years ago.

Those people rode the housing wave up and are riding it back down. I bought our first house in 2001 for 167,000. I sold it in 2005 for $296,000 and purchased another home for $400,000. My down payment on the new house included the gained equity from the first sale. I’ve since lost $65,000 in equity on the new house (about 17%), but I’m still way ‘above water’ from an equity position, even though I bought the current home 5 years ago.

We have a rental property in Oregon and we live in Texas. The rental is in a prime location and the total cost per month is $850 to escrow. We have charged less than that per month since we’ve been renting it out (a little over 5 years now) and currently rent it for $700/mo. There are several reasons why we do this.

1. We make it very clear that we live in Texas and the renter will not be able to call us to come fix a leaky toilet in the middle of the night or ever. They get a great deal on rent, we don’t have to pay for property management. Any repairs that are necessary to the house are taken care of by the renter, they send receipts with their rent, less the repair amount. If it’s a big repair needed and the renter can’t front the money, we work something out.

2. We aren’t hurting for money and aren’t looking for this to be a source of income yet but possibly when we retire in 30 years. Like was said above, as long as we are clearing interest, taxes and upkeep each month, any amount going towards principle we will recoup when we do eventually decide to sell. Maybe for some people that would mean they are recouping the payments towards principle as a smaller loss when they sell but since our house is in a prime location (location location), we haven’t seen much, if any depreciation in the value of the house (almost unheard of on the west coast). In fact, if we sold today we’d net at least 100k.

3. The house is a huge tax deduction because it’s considered a business for tax purposes. We take one or two trips a year to check on our rental and the house is always teetering on the edge of being a loss so some years we write it off as a loss. This is where looking at deducting the mortgage interest helps also. We are in the 33% bracket and getting 33% of the interest back on a mortgage someone else is effectively paying ain’t bad. Plus, it’s not our fault that it also happens to be in a resort town with an excellent ski mountain close by. =]

This post is not, however, endorsement for people to buy a family home as an investment, especially not for the tax write-off. That’s just plain silly.

It would be interesting to see how the numbers change in higher tax brackets, especially in areas where housing costs are very high. I wonder if there is a sweet spot for a certain set of people who can deduct a very large amount and not get hit with AMT.

Also, mortgage rates are so low now that it might have been a better financial outcome during periods like the 70s when interest rates were sky high (not great, but possibly better). Personally, I’m in the same boat with my annual interest costs barely clearing the standard deduction, even in the early years of the loan. Our property taxes are much higher than $1000 (married filing jointly), so between that, our ad valorem taxes on our cars and charitable donations, it at least takes a little of the bite out of how much we pay to the bank in interest. Ahh, the privilege of “owning” a home.

The tricky part is that if you have mortgage greater than $1 million, then you can’t deduct the mortgage interest, so while there is a sweet spot, it’s upper bound is limited by that $1m cap. Then again, if you have a million dollar house, the deduction is probably not that big of a deal anyway!

I would think, though, that people will be more willing to donate to charity since you can’t deduct that amount if you claim the standard deduction.

Also, your analysis shows how the inequity of the deduction, the rich benefit far more than the middle class or poor when it comes to this deduction. It helps someone with a much more expensive home (as long as the debt is less than $1 million) more than someone who owns a home worth less, since they pay significantly more in interest. For the rich, at least in the past, it made more sense to have a mortgage because they could deduct a lot and their cash they could have paid for the house would get a better return in other assets.

In general, the decision to rent/buy is pretty close to a wash in the end, which is why people spend endless hours and blog posts debating it. I think it’s important to point out a couple assumptions you’re making though. For the sake of disclosure, I am a homeowner.

First, you’re assuming you have no other items to deduct (for example, property taxes are also a deduction as well as charitable giving, etc). For example, this year, my interest deduction was close to the standard MFJ deduction. However when you took other deductions into account, the two numbers were nowhere close. Anything above and beyond the standard deduction is a net positive relative to your stats above.

Second, you are assuming that the amount you pay monthly for a mortgage on a home is greater than the amount you’d be paying for rent in your area by the amount of your interest. Otherwise your capital outlay is the same, and at least the amount you pay toward principle every month is not sunk forever as it would be if you were renting (I’m assuming the value of the home does not go down to zero). For example, if I’m looking at a $1200 mortgage (including principle, interest, tax and insurance) vs a $1200 rent payment at a comparable property, I’m looking at a net cost of ($1200 – principle payment) for the home every month instead of a cost of $1200 at the rental.

I really hope that all of this housing bubble stuff has changed the idea of “owning vs renting being a wash.” There are people walking away from homes for the simple fact that now the house is worth less then when they bought it, even though they can afford the payment.

There must be some gene that gets switch on at closing when someone buys a house that turns them into a person who believes “renting is just throwing money away” and I am smarter because I have a house payment.

To judge this debate by the last 10 years of the market would be a mistake. As you pointed out, there was a housing bubble that burst, which created a lot of market chaos.

John is mostly correct in his statement about it being a ‘wash’.

I say ‘mostly’ correct because in the long run, ownership tends to result in a slightly better savings position each year which has a compounding effect over the life of the typical property. Of course, there are too many variables in any situation to make a blanket statement that it’s always better, but reason would dictate that it is better to own.

There’s a great article at Free Money Finance about this same topic right now. The best way to go is to pay off the mortgage as soon as possible because 1) You are no longer a slave to the lender 2) not paying interest is a guaranteed ROI and 3) you will like the cash flow you have when it’s over!

Thanks for this article. This year is the first year we’ve had a house and mortgage to consider when doing our taxes. My husband was explaining that we paid less interest than the standard deduction, so we were better off with the standard, but I just couldn’t exactly understand why (my theory is that he wasn’t explaining it correctly). Now I understand!

1. the full amount of your real estate taxes paid, not just the $500/$1000 add-on to the standard deduction – this is VERY important in high property tax states like New York.

2. the state and local income taxes that you had withheld from your paychecks in 2009 – many people miss this one if they aren’t using tax software. If you have no state income taxes withheld, you can deduct sales tax instead, either the direct amount that you paid (if you have all of your receipts) or a “safe harbor” amount based on your income.

3. personal property taxes that you paid – in North Carolina, for example, we pay a personal property tax on our vehicles. Many people miss this one, too.

4. any other state or local taxes that you paid, if they are considered to be taxes under state law – for example, California treats the deductions for UI, ETT, and SDI as taxes.

Plus the less common deductions, such as charitable contributions, unreimbursed medical expenses in excees of 7.5% of your AGI, unreimbursed employee expenses up to 2% of your AGI, etc.

Jim’s basic point is correct, but I just wanted to make sure that people realize mortgage interest and charitable contributions aren’t the ONLY things you can deduct when you itemize.

You have to be careful with the “personal property” tax on cars. For some reason (as far as I can figure out through research), in MA our excise tax on a car is an excise rather than property tax, and so you can’t deduct it. I don’t see the difference, but I’m sure there’s one.

If the tax is based on the value of the item alone, and is imposed on a yearly basis, it is deductible on line 8 of Form 1040 regardless of what it is called. The Massachusetts excise tax certainly qualifies. (I’ve confirmed this with a tax pro who lives and works there.)

If it is based on anything OTHER than the value of the item, it is not deductible – for example, your vehicle registration fee, if it is a flat rate or variable based on the vehicle’s gross weight, would not be deductible.

But if you are a same-sex couple married in Vermont then the IRS doesn’t recognize your marriage and the property tax deduction really does help after all.

Also the deduction for tax preparation costs really helps since I have to file separate 1040s, one filled out for the IRS as a single person and one for the state of Vermont, married filing jointly. We’ve been doing this since 2001 when Civil Unions started and over the 9 years this has cost us somewhere around $15k between the 2 of us. Totally unfair, this is not a civil rights issue to us … it’s an economic issue … even more so now that I’ve retired and am living on a fixed income.

If you are single in California, and your AGI is more than $83,450, your state income tax alone exceeds the threshold for the standard deduction. When you add on the other state taxes that you can deduct in California (UI, SDI, etc.) it’s not at all uncommon for single people to be able to itemize based on state taxes alone. For married people it’s less common.

One thing to remember is that if you do itemize and deduct state income taxes withheld in 2009, and you then get a tax refund from the state, all or part of that refund might be taxable the following year.

Fact of the matter for us is that even with buying before the peak of the Silicon Valley market, a house cost $750,000 (20% down is still $600,000). The mortgage interest deduction makes a great impact to our taxes. With only $11,400 for a standard deduction, we have surpassed by about times 3 for a single year’s mortgage interest.

I’d stress that it’s something that depends very much on details. It’s a partial myth. In NY where you deduct state and local taxes that add up to almost the standard deduction, having the interest and property taxes on top it’s really a true deduction. But like anything that’s tax deductible you have to spend it to save, so in the end the math is kinda murky to figure out.

I’d consider this to be only a partial equations since rent payments are missing from the “net cash”, as is the principle payments for the homeowner. Rent payments, no matter how you want to dissect it, is money lost. The equation is far larger than just looking at the tax impact. Homeowners build equity which they then can capitalize on when selling the home. If I were to sell my home for the remainder of what I owed, I would pay less than I would have paid in rent for the same time period. The more likely scenario is that my home value appreciates, which of course swings the equation even more.

I think the point people are trying to make here, S, is that, like the housing bubble, the current down-turn in the housing market is not a permanent feature of our economy. It might have a long-term effect on it, but it will not define, necessarily, everything from here on out.

I think people are commenting here in a general and broad way on what the market CAN be like, over the long haul. Sure, there are some REALLY bad examples of what can happen to people if they don’t make the right decisions, but to assume that things won’t change (for better or worse) from their current conditions would be just as foolhardy as what people were thinking 5 years ago towards the end of the housing boom.

Like any other market, there are highs and lows. A lot of people bought high and lost when the housing market dipped. Wouldn’t it be foolish for people NOT to buy when they could buy low just because other peoplegot burned when they bought high? I’m not advocating market timing in regards to trying to decide when to buy, but there WILL be a low, and that WILL be a time when it will make more sense to buy than it was a couple of years ago.

Well, your assumption is those money can actually controlled by you to invest. However, to live at a rental similar to your house will cause more, and of course no deductibles. Think about this, if you have a landlord, would this landlord pay interests?pay property taxes? and where he or she get the money to pay those fees? It’s YOU.

I’m a homeowner and a landlord. My tenant doesn’t pay interest, he pays rent. However, his rent pays my principal, interest, taxes, expenses and profit. I rent well below the market rate to keep an excellent tenant. When I retire, I will have the equity in the house. The renter won’t. I’m not saying he’s throwing his money away, and I’m not saying I’m smarter than he is. We are each doing what works best for us in our own situations. It’s a fair arrangement, satisfactory to both of us.

I also own my home. I pay on a mortgage, so I pay interest. I haven’t itemized deductions in years, because my total deductions are not enough to exceed the standard deduction. I disagree with the math in the article, because it oversimplies reality. However, I agree with the principle 100%. I have preached it for years, and have never found anyone to agree with me.

It is far better if you don’t have enough deductions to itemize. You will be dollars ahead if you spend less than the standard deduction. However, if you have the deductions, you would be foolish if you don’t itemize.

The goal is to keep expenses below the standard deduction. Itemize if you can, but that just tells you that you need to find a way to reduce those expenses below the standard deduction level. Paying ahead on the mortgage is one good way to do that.

i love the standard deduction. i plan on renting for another several years, and then when i do buy, i plan on having such a small mortgage (or none at all ?) that i’ll still be taking the standard deduction.

my dad had always told me about the tax advantages of being a homeowner, but now it’s me going to him and explaining that his advice, though well-intentioned, was misguided!

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